Is Volatility A Good Predictor Of Financial Bubbles?

The answer may surprise you…

Since bubbles in financial assets aren’t something we experience on a weekly basis, there’s not a lot of mental recognition of the environments that surround them. Ask someone a question pertaining to the 2007 peak in stocks and volatility and they’ll likely point to who volatility was well off its low by the time the major stock indices put in their peak. If you were to ask me the same question that’s probably the answer I would have given too. This response is what makes this recent research by three professors in Zurich Switzerland so interesting.

Titled, “Can We Use Volatility to Diagnose Financial Bubbles? Lessons from 40 historical bubbles”, Sornett, Cauwels, and Smilyanov studied the past 40 bubbles in financial history from markets, commodities, to individual stocks in order to uncover if there was any commonalty to volatility before the bubbles burst.

Keep Reading: Is Volatility A Good Predictor Of Financial Bubbles? (See It Market)

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

The Market Just Did Something We Don’t See Happen Very Often

2017 has been a year of setting records. We’ve seen a record level of low volatility, a record amount of time without a 5% decline in U.S. equities, and what has to be a record amount of natural disasters taking place. One we can now add to that list comes from the technical analysis column of the ledger.

To go along with the running count of days without a large decline in the market, we’ve now had three consecutive weekly closes above the S&P 500 weekly Bollinger Band. Bollinger Bands are often used to show two standard deviations above a chosen moving average, often 20 periods. For today’s post, I’m looking at weekly data so I am using a 20-week Moving Average.

We last saw this occur in July of 2016 but we’d have to go to 2007 to find the next example. In fact, it’s something that’s only occurred less than 2% of the weeks since 1950. Now a sample size of 57 is rather small, especially when the data set goes this far back. This is not an overly bearish piece of data, while it did precede some interesting turning points in market history (i.e.: 1961, 1972, 1987, & 1999). Any of those stick out to you? Probably so.

As I mentioned, we last saw this occur in 2016, just before the only material decline that occurred in ’16 before U.S. equities picked themselves up, dusted themselves off and marched on to continue hitting new highs. So can consecutive weekly closes above the upper Bollinger Band lead to market weakness? Yes, we saw a 17% decline in ’61, we all know what happened in ’87, and we experienced a double-digit drop in ’99 after this occurred as well. However, many times the market either ignored this interesting piece of data, saw a short-term consolidation, or declined slightly and continued higher.

Here are three charts to show the past occurrences. The red dots indicated when the S&P 500 closed consecutively for three weeks more than 2 standard deviations above its 20-week Moving Average:

So if the resulting market performance is so mixed why am I sharing this? Because I’m fascinated anytime the market does something that is unique or rare. While it’s only happened 57 times in 67 years, some of the dates have been extremely important to financial history! That to me is very interesting.

Data used from Yahoo! Finance.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

The Recent Breakout in Gold

There’s been a lot of discussion recently of the breakout in gold prices. The yellow metal had been trading in a range for the last several months, seeing resistance just under $1,300/oz and support at $1,220/oz. While I do believe the breakout is encouraging and does align with seasonality for gold, there’s one piece of data that’s yet to confirm the upside move.

Below is a chart of gold in the top panel and the Japanese Yen in the bottom panel. Looking for divergences and confirmation for gold in the yen has been an effective tool in analyzing gold prices. For example, back in late-2015 we saw a slight higher low in the yen while gold made a lower low/double bottom. Something similar occurred in late-216 with a bullish divergence in the yen. Both events led to reversals and ultimately up trends in gold prices.

More recently during the consolidation in gold this year we saw a small break higher in June for gold, but did not see a confirm in the yen, which was quickly followed by a reversal in gold prices as they remained in a range. A second break soon followed, with gold falling below the May low and many began calling for gold to make another leg lower. However, we did not see a confirmation in the lower low in the Yen and gold bounced back.

Now we have gold breaking out above the April and May highs and calls have begun for gold to quickly test its 2016 highs. Unfortunately, once again, we aren’t seeing confirmation in the yen, as the currency is still below its own 2016 high and has actually moved slightly lower since the initial breakout in gold.

Going forward, I’ll be keeping a close watch of this pair, looking to see if the yen eventually does move higher and joins gold prices in breaking out of its own respective range. Or if gold loses its strength and falls back below $1,300/oz.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.